Using Home Equity

truliantfcu.balancepro.org USING HOME EQUITY

There are numerous benefits to owning your own • Square footage home. Not only does it provide you with a place to • Number of bedrooms and bathrooms live, but you can also often use the accumulated • Construction quality, design, and floor plan equity for a whole host of money-smart purposes. • Neighborhood Borrowing further against your home is serious • Lot size, view, and landscaping financial decision, though, and should only be done after careful research and consideration. Once you know your home’s current market value, subtract the amount you owe on your mortgage(s) Home Equity: Defined and Calculated to calculate your equity.

Home equity is the part of your home’s value that Second Mortgage you own outright or, more specifically, the current market value of your home minus your outstanding If you already have a first (primary) mortgage, mortgage balance(s). Equity can be built by making another loan taken out against your home is called a a down payment to purchase the home, paying second mortgage. Second mortgages come in two down the principal of the mortgage through making basic forms: home equity loans and home equity monthly payments, and the value of your home lines of credit. Both types typically come with a appreciating (increasing). Appreciation occurs when higher interest rate than for primary mortgages market demand rises – for example, if you bought because the lender assumes greater risk – in the the home for $200,000 a few years ago, it may sell event of foreclosure, the first loan will be repaid today for $250,000 because prices for homes in before any seconds. However, because the loan your area have increased. Your property may also is still secured by the property, the interest rate appreciate in value if you made repairs or home for second mortgages tends to be lower than for improvements. unsecured debt, such as credit cards and personal loans. While most homes appreciate in value over time, it is also possible for the market value of a home to Home equity loan decrease. Economic instability is a general cause With a home equity loan, you receive cash in one of depreciation. There could also be something lump sum at closing. Once you get the money, you negative that happens to your home or in your cannot borrow further from the loan. The repayment community (such as increasing crime) that brings period is often fifteen years, although it can be as down the value. If the amount you owe on your little as five or as great as thirty years. Both the mortgage is greater than the value of your home, interest rate and the monthly payments for a home you are said to be “upside down”. equity loan are usually fixed, meaning they do not change over time. To know how much equity you have in the home, you will first have to find out its value. To get that Home equity line of credit (HELOC) number, you can either do a comparative market A HELOC is a type of revolving credit. It operates analysis or have your home professionally appraised. similarly to a credit card. You can withdraw money, up to your credit limit, at any time during the draw A comparative market analysis is an informal period. Some lenders set a minimum required estimate of your home’s market value. It is typically withdrawal amount or charge a transaction fee every done by a real estate agent, who looks at “comps” time you draw on the line. During the draw period, – comparable homes that have been sold recently. you typically are only required to pay the interest, Many agents will do this for free. You can also use a although you can choose to pay principal as well. home value calculator, which can be found on many Once the draw period is over, you may have to repay real estate websites. the full principal in one balloon payment, be allowed to repay the principal over a fixed period of time, For a more precise estimate, you may choose to pay or have the option of renewing your draw period, a qualified appraiser (which typically costs a few depending on how the HELOC is set up. hundred dollars). The appraisal takes many variables into consideration, including your home’s:

The interest rate for HELOCs is usually variable, However, you can consider what you will use the meaning it can change over time. It is usually funds for. People generally take out a home equity calculated as a base index, such as the prime loan to pay for a specific, one-time cost, such as rate (the rate financial institutions give their most credit card debt or an addition. Conversely, when creditworthy members), plus a margin. Because the people expect to use the funds over a period of time, interest rate affects your monthly payments and how a HELOC is often used. much borrowing will cost you, it is a good idea to be aware of how much the rate can increase each Tax benefits adjustment period as well as over the life of the loan. For taxpayers that itemize their deductions, the interest that is paid on a second mortgage is How much can you borrow? deductible. However there are limits – unless the loan How much you get from a second mortgage is based proceeds were used to substantially improve the on your equity since it is your equity that is serving home, you can only deduct the interest paid on the as collateral for the loan. (Of course, the lender will first $100,000 of the second mortgage or the fair consider your income as well, and you will need a market value of the home minus the first mortgage good credit score to be approved for the loan in amount, whichever is smaller. More information is the first place.) Every lender sets their own limit, available at www.irs.gov. although it is commonly less than the full amount of equity. Still, there are some lenders that may let Refinancing you borrow up to the amount of equity you have or even more. It is never recommended that you borrow Refinancing is the process of paying off the existing more than your equity, as this puts you upside down. mortgage(s) with the proceeds from a new loan and It can be difficult, if not impossible, to sell your home using the same property as collateral. The refinanced while you are upside down. mortgage becomes your new first mortgage. Refinancing can be done with your current lender or What a lender is willing to give you is not the only a different one. Unless you take cash out, refinancing factor. You should also consider what you can afford does not involve “using home equity” but it is to repay. The more you borrow, the higher your still helpful to understand the situations in which monthly payments are. Remember, home equity refinancing may be beneficial: loans and lines are secured loans. If you do not make the payments, the lender can foreclose on Refinancing to reduce the interest rate your house, just like if you do not pay your primary Interest rates constantly fluctuate, and many mortgage. homeowners refinance their mortgage because the rate they can get today is better than the one on Choosing a loan their original loan. A reduced interest rate provides Looking for a loan with a low annual percentage rate the benefit of lowering the monthly payment, which (APR – the cost of borrowing expressed as a yearly puts more cash in your pocket. Will it save you rate), is a good idea, since the lower your interest money in interest? That depends. Stretching out rate, the less borrowing will cost you. You also want the future repayment period to 30 years instead of to consider the closing costs (fees that are charged whatever time is left on your existing mortgage will to process and disburse the loan). When you apply at least partially offset the interest savings (although for a mortgage, the lender is required to give you an you can pay extra and get rid of the mortgage estimate of these costs in the Good Faith Estimate. quicker than 30 years). Additionally, when you Comfort is relevant too – if a lender is putting refinance, you have to pay most of the same closing excessive pressure on you to borrow and does not costs you paid the first time around. To determine answer questions openly, you probably want to go if refinancing to a lower rate is financially beneficial, with someone else. you can use the “Should I refinance calculator?” at www.balancepro.net/education/calculators.html. You may be wondering if it is better to get a home equity loan or a home equity line of credit. Because Refinancing to lower the payment the APR for home equity loans and HELOCs are Getting a lower payment with refinancing can be calculated differently, comparing the two isn’t easy. achieved by lowering the interest rate, extending The APR for home equity loans may include points the repayment period, and/or refinancing for less and other finance charges, while the APR for a home than what was initially borrowed. While lowering equity line is only based on the periodic interest rate. payments can provides relief to those with cash

COPYRIGHT © 2019 BALANCE 0119 2 truliantfcu.balancepro.org flow problems – and possibly prevent foreclosure – and the loan’s interest rate. remember that having a lower payment means that • Single-purpose reverse mortgages are you may pay more interest in the long run. offered by some government and non-profit organizations to low or moderate-income seniors. Refinancing to get cash out Though borrowing costs tend to be inexpensive, With a cash-out refinance, you refinance your availability is limited, and the cash can only existing mortgage and also borrow an additional be used for a specific purpose, such as home sum from your equity at the same time, giving improvements, repairs, or property taxes. you cash that you can use for whatever you want. • Proprietary reverse mortgages are private loans Depending on your new interest rate and how much and are typically the most costly option. They cash you take out, it is possible that your mortgage may be appropriate if your home’s value is very payments will increase. Before you take the cash out, high since they can give a bigger cash advance you should carefully consider if you can handle the than HECMs. increase in payments. The basic requirements to qualify for a HECM are: How much can you borrow? How much you can refinance for depends on the • Everyone on the title of the home must be at value of your house and what percentage of your least 62. home’s value your lender allows you to borrow. Some • You must occupy the property as your primary lenders may let you refinance up to 100% of the residence. value, but you may have to pay for private mortgage • There must be a significant amount of equity in insurance until you rebuild 20% equity. Additionally, the home. like with second mortgages, your income and credit • You must complete a counseling session with a score will also be considered. housing agency approved by HUD. (You can call (800) 569-4287 or visit https://entp.hud.gov/ Reverse Mortgage idapp/html/hecm_agency_look.cfm to find an approved agency. Many seniors find themselves with a limited income but a significant amount of equity in their home. A Unlike with a traditional mortgage, you do not reverse mortgage is a tool that allows you to take need a good credit score to qualify for a reverse the equity out of your house without having to mortgage. sell it or make payments. (In some circumstance, it can also be used to purchase a home.) Like the While a reverse mortgage can increase your cash name implies, a reverse mortgage is the reverse of flow, there are a few downsides to consider: a traditional mortgage. With a traditional mortgage, you make payments on your loan to the lender • It typically costs more than a traditional each month, increasing your equity and decreasing mortgage. The closing costs and mortgage your debt. Eventually, if you stay in the home, you insurance premiums can be quite high. (The will own it free and clear. With a reverse mortgage, HECM Saver comes with lower costs than a the lender pays you instead, reducing your equity regular HECM, but you cannot borrow as much.) and increasing your debt (since the money is a loan It generally does not make sense to get a reverse against your home’s equity). You do not have to mortgage if you plan to move within a few years. pay back the mortgage for as long as you live in the • Your total debt increases rather than decreases property. over time. • Since you are using some or all of your home’s There are several types of reverse mortgages: equity, you are leaving less money to your heirs.

• Home Equity Conversion Mortgages (HECMs) Factors to Consider are the most widely available type of reverse mortgage and are backed by the Department of For some, getting a second or reverse mortgage Housing and Urban Development (HUD). There or refinancing could be the best option, for others, are no income restrictions, and you can use the a mistake. Since you are putting one of your most money for whatever you like. The amount of important assets – your house – on the line, it is money you can borrow depends on your age, important to think carefully before acting. your home’s value, where your home is located,

What will the equity be used for? doing a cash-out refinance may only make your situation By using your home’s equity, you are decreasing your worse. Even if you want to use your equity for a responsible wealth and increasing your debt, so make sure you purpose, it is not a good idea to borrow if you cannot afford are using the money for a worthwhile purpose. Do you to make the payments. really want to take out a home equity loan so you can go on cruise? Popular uses of home equity include: What are the benefits? In general, the lower the risk to the lender, the less interest • Consolidating unsecured debt. Credit cards and you will have to pay. A loan secured by home equity does not personal loans often come with a high interest have as much risk as a loan without collateral, so the interest rate. A loan secured by your home will usually rate for home loans is usually lower than that for credit cards have a better interest rate and smaller monthly and personal loans. The repayment period is usually longer as payment, and the interest paid will likely be tax well, which makes borrowing large sums of money more deductible. Also, if you have many accounts, affordable. Also, in most cases, the interest that you pay on a consolidating them into one payment can make loan secured by a personal residence is tax-deductible, unlike your life much easier. Still, it is important to keep the interest paid on a credit card or personal loan. in mind that you are turning unsecured debt into secured debt. If you do not pay your credit cards, What are the alternatives? your house cannot be taken from you, but it can If you need or want money, borrowing against your equity is if you do not pay your first or second mortgage. not the only option. For example, you may be able to use Additionally, sometimes, when people pay off credit cards or personal loans. The interest rates may be unsecured debt with their homes, they just wind higher, but you do not put your home at risk. If you decide up maxing out their old cards again, giving them you can wait, you can save for your goals and perhaps avoid more debt than before. borrowing completely. Selling your house is another option. It • Financing home improvements. Perhaps you allows you to access your equity without needing to worry want to change the cabinets in the kitchen, about repayment. upgrade the bathroom, or add a whole new The Right to Cancel room. Home improvements can be expensive, and many people do not have the savings to If you decide to borrow, but then regret it, you may be able to pay for them. While renovations can increase cancel if you act fast. The Truth in Lending Act, a federal law, your enjoyment of the house, as well as its gives you the right to cancel a loan secured by your home value, remember not to borrow more than what within three business days following the settlement, receipt of you can afford to pay back. Think about what your disclosures, or receipt of your cancellation notice, projects can wait if you have limited funds. whichever occurs last. You must notify the lender in writing, • A source of savings. Many people take out a and you can only rescind if the loan is secured by your home equity line in lieu of saving. Why not? The primary residence, not a vacation or second home. In money is there when you need it, and you do not addition, you are not given the right to cancel if you obtain have to pay interest until you withdraw the funds. the loan to buy or build your primary residence or are Unfortunately, it does not always work out. Your refinancing your loan with the same lender who holds your credit line can be frozen, meaning you will be existing mortgage and do not borrow additional funds. no longer able to use the funds that were once available to you, or you be in a position where Summary you cannot afford to repay what you borrowed. You could take out the money before you need Chances are, you worked hard to buy your home. Don’t make it and put it in a savings account or invest it, but hasty decisions that can put it at risk. Read all paperwork the money is not really savings, since you need thoroughly, and make sure you understand all of the terms to pay it back. Also, it will cost you if the interest before you sign anything. If you need to, get legal assistance. you are charged on the home equity line is higher When done for the right reasons and under the right than the interest you earn from your savings circumstances, using your home’s equity can be a wise account or investments. financial decision.

Is the monthly payment affordable? Schedule your private one-on-one for Never forget, if you cannot make your payments, personalized financial tips today! you can lose your home. If you take out a second Marina Botros mortgage or, in many cases, do a cash-out refinance, Email: [email protected] your monthly payments will increase. If you are Text: 336.703.8209 struggling now, taking out a second mortgage or Phone: 336.659.1955, option 7, ext. 2702 COPYRIGHT © 2019 BALANCE 0119 4